Originally published June 5, 2021
Everyone makes mistakes and it’s up to the small investor to accept these as part of the learning process. It’s only human to avoid thinking of these train wrecks and move on as fast as possible, but that would be a lost opportunity in learning something.
My Mistake
I am referring to the sale of my Game Stop option in which I murdered 85% of my capital. So where did I go wrong? For the most part, I reacted too quickly to an opportunity that I felt had a limited-time offer. The stock was catapulted beyond logic by a group of amateur investors leveraging social media. Betting against them sounded like a sure thing at the time. That being said I purchased a complicated option without fully understanding the mechanics of the trade. Essentially I was betting for a large move in the stock in the down direction. This did occur – it fell from over 300$ to 40$. However, the volatility premium that I paid for the option was so high that it overwhelmed the effect of the move down creating very little added value in the option. The volatility then fell and the stock rose, basically eroding the volatility premium I paid so much for.
So What Did I Learn?
Do not jump into something without doing your due diligence. Remember that the seller of options has the advantage. Know that even if you have the right direction, magnitude, and timing in an option, you can still lose on something else like volatility. Three out of four factors were correct, but that was still not good enough…..it usually is.
Why did I not just hold till expiry you ask? My wealth advisor, who manages my retirement portfolio, asked if I have any potential capital losses in the hobby portfolio as he is having a good year and will likely be declaring net capital gains on the account. This creates a tax burden for me, which can only be offset by a capital loss. By selling the option I create a capital loss, and this will offset the gain at tax time next year. Generally, you can expect the offset to gain you back about 15 to 25% of the loss depending on your marginal tax situation. It’s not a lot, but everything helps.
The Strategy
The strategy for this position is not over. Effectively I still believe that GME will fall in the future and it’s still a viable bet. The plan is to wait the required tax selling period of 31 days and repurchase the option. This allows me to keep the capital loss deduction and continue the trade as a new position. I am assuming that all will remain equal for 31 days, but who knows what will happen in the future, so I will have to assess the market situation and make sure the bet is still viable. In any case, repurchasing it will be only a few hundred dollars so I am doing this more for educational purposes to see how the story eventually plays out. It’s not statistically very important in the bigger picture.
How Do You Protect Yourself… From Yourself?
That is really a difficult thing to do and to me, the answer lies in the discipline or a set of rules that you attribute to investment decision-making. In my case, I had already declared that the GME option would be a speculative position and as a result, should never exceed 2-3% of the portfolio (my own rule). To be clear, all speculative positions combined can never exceed 2-3% of the portfolio. In this case, GME represented about 1% of the total value of the portfolio. This rule as simple and ensures that if things go wrong, the worst-case scenario will not ruin your returns for the year or future years. A total loss, in my case (pretty close actually), means that 99% of the portfolio survives and the loss is barely noticeable in the big picture. One percent can easily be made up in other years with good decisions and a bit of luck… it’s not terminal.
I will throw in one of my other related rules. No regular position within a portfolio should exceed 5% of the total. The same logic applies here, in that should one of your positions go bankrupt or fall into a sinkhole, 95% of your portfolio survives and again the loss can be made up. As an example, should you only have 3 positions in a portfolio and one of the three goes bankrupt, you will likely never recover and in hindsight maybe you should have bought a market ETF. The 5% rule lowers your diversification risk by ensuring that you have at least 20 stocks and as a result, lowers your annual standard deviation (how much your portfolio zigs and zags).
If you applied these rules to your portfolios, would you pass my tests? Do you even know? Maybe you have a few too many Bitcoins, Tesla shares, or AMC. Maybe you are too concentrated in one sector (remember the tech bubble circa 2000). It’s easy to get enthusiastic about a particular stock or type of stock and then buy too much, or maybe your stock skyrocketed and without knowing it, your portfolio now depends on how well Tesla does as most of the value of your portfolio is concentrated on one stock.
Happy investing… oh, and try not to suck.
Marc’s Monthly Moves
| Buy | Sell |
| GameStop (GME) Put POption |
Marc’s Portfolio YTD Performance
- Portfolio return 5.8% (Including currency losses/gains)
- Portfolio return 11.0% (without currency losses/gains)
- SP 500 return 12.6%
The portfolio under-performed the SP500 by -1.6 points.
Money with Marc 